Momentum Builds for Oil Prices at US$100 a Barrel

Oil & Gas
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Tuesday, January 25, 2021, / 04:45 AM / by Tosin Ige, Proshare Research / Header Image Credit: Getty Images


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The global oil prices hit 7-year highs last week as Brent crude futures briefly touched US$89 per barrel. In contrast, US West Texas Intermediate (WTI) crude futures hovered around US$85 per barrel on the expectation of supply disruption following a series of fatal attacks in the Middle East and geopolitical tension in Eastern Europe. The global oil market started with demand-supply imbalances due to outages and maintenance repairs across many oil-producing nations. 


The market remains under-supplied as OPEC plus, and the US shale producers cannot match supply with the speedy recovery in demand. The combination of existing imbalances and the recent expected disruption is looking to tighten the market further, steadily pushing oil prices towards $100 per barrel early in the year. With oil prices rising by 13% YTD, several factors could trigger the $100 per barrel forecast in the short term.


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Middle East Tension

On Monday, January 17, 2022, a Yemen-Iran Houthi militia launched a fatal attack on the United Arab Emirates (UAE) following the interception of its earlier drones targeted toward Saudi Arabia but seized by a Saudi-led coalition. This came barely two weeks after the Houthi group confiscated a UAE-flagged vessel on the Red Sea. Analysts considered the attacks a threat to UAE to desist from further alignment with the Saudi-led coalition.


The recent Houthi attack on UAE killed at least three people, injured many, hit a fuel depot, and caused a fire outbreak near the Abu Dhabi International Airport. In what seems like a counterattack, just a day after the incidence, the Saudi-led coalition claimed some airstrikes on Yemen's capital city -Sanaa, that killed at least 20 people. According to Saudi media, the Saudi coalition has begun airstrikes against the camps and strongholds of the Houthi Group in Sanaa. What follows is a series of attacks to date in the region and the possibility of further escalation.


Overall, the oil market may bear the brunt as the Middle East accounts for a significant global oil supply. Saudi Arabia and UAE are the first and third-largest oil producers of OPEC. By implication, the tensions (in terms of expected disruptions) have impacted oil prices for two straight weeks. There is the likelihood of actual supply disruption in case of further escalation, fueling higher oil prices.


Eastern Europe Tension

Russia has been stepping up its preparedness to invade Ukraine for the past few weeks. With over 100,000 troops massed along the Ukrainian border, investors are bullish on oil prices expecting the geopolitical risk between Russia and Ukraine to disrupt supply in the near term significantly.


Last week diplomacy between the US Secretary of State, Antony Blinken, and its Russian counterpart, Sergei Lavrov, yielded no outcome as the Kremlin insisted on its demands which the US said are impossible to meet. Essentially, Kremlin demands an end to NATO expansion to new members, especially countries under its threat, such as Ukraine. UK foreign office on Saturday also stated that the Russian Government intends to "install a pro-Russian leader in Kyiv as it considers whether to invade and occupy Ukraine".


With considerable fear of oil supply disruption already on the horizon, the eventual invasion of Ukraine by Russia will generate harsh economic sanctions from the US and the European Union. This is expected to have dire consequences on the oil market, given that Russia is the largest non-OPEC producer. Additionally, Russia accounts for 35% of Europe's natural gas supply, with some pipelines passing through Ukraine, including the highly controversial Nord Stream 2. Europe's energy market is likely to bear the brunt of the tension if it degenerates into total conflict.


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Weather Factor

The expectation of a colder winter due to an expected cold snap and the possibility of additional Arctic blasts would boost heating demand and spur increased oil and natural gas prices.


Meanwhile, the freezing temperatures could also lead to interruptions at some oil fields. Essentially, a combination of increased oil and gas demand for heating during this cold winter and the prospect of a drop in supply because of freezing temperature would contribute to the imbalances in oil and natural gas prices.


OPEC Capacity and Underinvestment

The Organization of Petroleum Exporting Countries (OPEC) and its other producers' allies (OPEC+) is struggling to meet its monthly output increase of 400,000 barrels per day (b/d). According to Reuters and OPEC, OPEC+ compliance with oil production cut rose to 122% in December from 117% in November to 116% in October 2021, an indication that production is dropping below the agreed targets.


There are indications that the top OPEC+ members, Saudi Arabia and Russia, are poised to maintain the current rally in oil prices by providing the "needed" support. However, African producers such as Nigeria, Algeria, and Angola may continue to destabilize the oil market due to underinvestment and below quota production. While Nigeria has failed to meet its oil production quota since July 2021, Angola has been missing its quota since September 202o. Such underproduction and falling spare capacity are likely to keep oil prices higher.  


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Shale Production Signal

Recent data from the US Energy Information Administration (EIA) revealed a decline in drilled but uncompleted wells (DUCs) in major US onshore oil regions. The December Drilling Productivity Report (DPR) showed that DUC wells across 7 US regions fell from 4,830 in November to 4,616 in December 2021. It is true that higher completion rates have been leading to an uptick in oil production, particularly in the Permian; however, those completions have sharply lowered DUC inventories, which could limit oil production growth in the United States in the coming months, according to Alex Kimani of Oilprice.com.


The US shale producers are currently facing a dilemma after rejecting new drilling and focusing on dividends and debt paydown. However, with low inventory levels, the Shale producers cannot meet their new dividend payout and debt paydown objectives without increasing drilling activity investment.


Nonetheless, with sustained discipline on moderated spending by Shale producers, supply would continue to lag demand and push oil prices further higher.


Demand Concerns

OPEC has stuck to its forecast of robust growth in world oil demand in 2022 despite the Omicron Covid-29 variant and expected interest rate hikes by Central Banks of advanced economies, foreseeing the oil market would remain supported in 2022. OPEC expects world oil demand in 2022 to rise by 4.15 mb/d and surpass the 100 mb/d mark in Q3 2022.


According to the cartel, "while the new Omicron variant may have an impact in the first half of 2022, which is dependent on any further lockdown measures and rising hospitalization levels impacting the workforce, projections for economic growth remain robust".


With the expectation of robust demand and potential rationing given the expected supply disruption, oil prices may remain elevated for the better part of 2022.


Oil Predictions

The consensus among analysts and investment bankers is that the current oil market situation will not improve in the near term. That increase in oil demand, together with supply disruptions, would lead to a tighter oil balance.


Goldman Sachs analysts expected oil inventories in OECD countries to drop to their lowest level in over 20 years in Q3 2022, with Brent oil prices hitting $100 later in the year.


JPMorgan expected oil to hit $125 a barrel this year and US$150 in 2023, while Morgan Stanley expected Brent crude price to hit US$90 a barrel in Q3 2022.


On solid demand and supply constraints, local analysts have also predicted oil prices between US$65 and US$100 per barrel. All things being equal, oil prices will maintain their current trajectory in Q1 2022 but revert mildly in the second half of the year as the uptick in prices would spur the investment appetite of OPEC and non-OPEC producers to ramp up production and supply.


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